Commodities countries first in line to hike rates: economists

Expected rate increases in Australia, Canada, Norway would support currencies

By

LauraMandaro

This update corrects the rate move by Israel's central bank.

SAN FRANCISCO (MarketWatch) -- A far-flung group of countries that have benefited from rebounding commodities prices is getting ready to raise benchmark interest rates before the United States, Europe and some other major, developed countries, economists say.

Those rate hikes are likely to give fresh momentum to five-month rallies to the Australian, Canadian and New Zealand dollars, as well as the Norwegian krone, while weighing on the U.S. dollar, the Japanese yen and, to a lesser extent, the euro.

Higher commodities prices "have allowed Australia and Canada to have a source of strength to have earlier reversals of their monetary policy," said Stephen Gallagher, chief U.S. economist at Societe Generale.

As resource-rich countries benefited from rising metals, oil and some agricultural prices, they also largely have avoided the financial-system convulsions that shook the United States and Europe.

For the commodity countries, "the likelihood of a second downturn is remote and their financial institutions are in better shape," Gallagher added.

Canada is likely to raise rates in the second half of 2010, according to Societe Generale.

Some forecasters see hikes coming even faster. Last week, J.P. Morgan Chase moved up its forecasts for rate hikes in Australia, Norway and South Korea (which has been recovering thanks to reasons outside surging commodities prices) to the first quarter of 2010.

Barclays Capital also says Norway, a big oil exporter, could hike rates by the end of this year.

The United States and Europe, in contrast, are likely to hold off until 2011. The Bank of Japan could wait even longer than the Federal Reserve and the European Central Bank. That's a knock against the U.S. dollar, yen and euro. Low interest rates tend to turn away foreign buyers of a currency.

"We don't like currencies in countries that we think will have low rates for a good long time, such as the U.S., Switzerland and Japan," said Steven Englander, head of foreign exchange for the United States for Barclays Capital.

The expected tightening among commodities countries and some other fast-growing nations would follow a year when many central banks cut rates to all-time lows, sometimes in a coordinated fashion, as they tried to prevent a collapse in the global financial system rooted in a U.S. housing bust and a massive flight to cash.

"What's unusual about this cycle is how low policy rates have gotten," said Bruce Kasman, chief economist for J.P. Morgan Chase. What's more, "other cycles have generally not been as synchronized."

On Monday, Israel kicked off what's expected to a round of hikes by larger central banks, surprising markets by raising its benchmark rate by a quarter-percentage point, to 0.75%. Read more on Israel.

First movers

After the most severe recession in generations, some countries are starting to grow faster than others. That's partly due to commodities prices, which have surged on expectations that China and other newly industrialized nations would start buying more.

Oil futures have touched $75 a barrel, approximately more than double their February lows. Copper prices have also doubled since their lows, reached in late January, to about $2.85 a pound.

Australia, for instance, now looks like it managed to avoid a recession, thanks in part to raw-material exports to China and elsewhere. The Reserve Bank of Australia said earlier this month it expects the economy will probably manage to expand this year, in contrast to many developed countries, and signaled it was getting ready to increase interest rates. Read more on Australia.

Metals and fuel make up about 45% of Australia's exports.

Canada, an exporter of energy and metals, also has been riding the rally in commodities. The Bank of Canada has said it anticipates the economy has stopped shrinking, and will keep rates at 0.25% until the second half of 2010. After that, analysts say, they anticipate a hike.

Barclays Capital is expecting increases in policy rates at the beginning of next year in Australia and New Zealand -- a producer of beef, wool, dairy and forest products.

Commodities aren't the only driver. The United Kingdom and South Korea make the list of early movers thanks to signs of life among their economic indicators.

"It's mostly commodities currencies, with one exception -- sterling," said Englander at Barclays Capital. The United Kingdom could raise rates in February, he added.

More momentum

Higher rates should support currencies that already have made double-digit gains since hitting March lows.

Since March 6, the day the S&P 500 Index
SPX, +0.29%
hit an intraday low for this cycle and setting off a global rally in stocks, bonds, currencies and commodities, the Australian dollar has jumped 30% against the U.S. dollar.

The New Zealand dollar has rallied 36%, Canada's dollar has gained 19% and the Norwegian krone has advanced 17%.

Several of these currencies also have made steep gains against the yen.

In contrast, the U.S. dollar index
DXY, +0.57%
which tracks the greenback against a basket of six currencies, has fallen 12% since March 6.

In general, J.P. Morgan says, the countries that were on the periphery of the global meltdown, which include several emerging-markets countries, are likely to raise rates before the biggest developed countries. Besides fewer cracks in their financial systems, these countries have less excess capacity.

"There are reasons for emerging-market countries to begin, on average, to adjust their policies more quickly," the firm's Kasman said.

A shaky recovery in the banking systems on both sides of the Atlantic will likely keep the Fed and ECB on hold until at least 2011, according to economists.

Fed squares off with ECB

Still, analysts say the euro could still have an edge on the U.S. dollar, thanks to a tighter interest-rate policy at the European Central Bank than the Federal Reserve.

The ECB has cut rates to 1% vs. the Fed's range of zero to 0.25%.

Plus, the Fed has been more aggressive on pursuing a quantitative easing program, expanding its balance sheet to about $2 trillion as it buys bonds and makes loans to the private market.

Axel Merk, chief investment officer at Merk Investments and manager of the Merk Hard Currency Fund
MERKX, -0.86%
said he expects the euro will gain against the U.S. dollar.

That's partly because he anticipates the Fed will keep rates lower and money looser than its European counterpart in a bid to drive growth -- even risking that low rates will stoke inflation.

"The Fed wants to have inflation, wants to have the price level to go higher, whereas the ECB is highly concerned about inflation," Merk commented. "When you devalue the currency and push for inflation, you may get higher growth. The Europeans may not get growth, but the currency will be fairly strong because they will be tight."

Japan is also not expected to rush to raise rates higher than the current 0.1%. The dollar has lost about 4% on the yen since March 6.

"Their financial institutions are in better shape, but they are sensitive to the financial climate," Societe Generale's Gallagher said. "We don't expect them to raise rates for some time."

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